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How Did You Manage That, JDS Uniphase?

Keep an eye out for suspiciously spotless earnings.

In 2000, General Electric posted its 100th consecutive quarter of growth in continuing operations. That's 25 years. Raise your hand if that sounds just a bit suspicious. Whatever business you're in, that feat just isn't possible unless your company's managing its reported earnings.

According to a 1998 survey, 78% of CFOs attending a given conference said they'd been asked to "cast financial results in a better light" without running afoul of GAAP. Half said they'd done it. Nearly half said they'd been asked to misrepresent their company's numbers, and 38% admitted they'd done so. Another survey at a different conference found that more than half of the CFOs attending had been asked to juice their numbers, and 17% had agreed to do so.

It's easy to understand why companies succumb to the incredible pressure to make it look like they've met or beaten targets or Wall Street expectations. Consistent growth is a feather in any CEO's cap, and a rising stock price often increases many executives' compensation, especially from stock options. But when companies stray from merely managing their numbers within GAAP into outright fudging them -- Enron, Sunbeam, we're looking at you here -- they can ruin themselves and their shareholders.

How can we spot suspicious earnings patterns soon enough to save ourselves? We can track how closely a company meets earnings expectations, monitor its frequency of year-over-year growth, and compare those stats to numbers from a few competitors, which should be affected similarly by changes in the business cycle. Any company that lands eerily close to earnings-per-share (EPS) expectations, and grows earnings year-over-year with unusual reliability, should raise a yellow flag and invite us to look closer.

Here's a look at what JDS Uniphase(Nasdaq: JDSU), an optical communications giant, has done over the past few years. I've also included F5, which has a suite of products to optimize network traffic, and which benefits from the same trends increasing demand for optical components, and Rofin-Sinar, which battle JDS directly in the laser market.

Company

Reported EPS Within $0.02 of Estimates?

How Close to Estimates, on Average

How Often It Reported Growth

JDS Uniphase

16 times in last 26 quarters.

$0.02

11 times in last 22 quarters.

Rofin-Sinar Technologies(Nasdaq: RSTI)

8 times in last 25 quarters.

$0.03

15 times in last 21 quarters.

F5 Networks(Nasdaq: FFIV)

18 times in last 27 quarters.

$0.02

18 times in last 23 quarters.

Source: www.earnings.com and author calculation. Difference in number of quarters counted due to data source.

In my view, there's not too much to worry about here. Yes, JDS has come close to analysts' numbers more often than not, and its average is also pretty close, but it hasn't consistently reported yearly growth. Of the other two, Rofin-Sinar seems fine, but F5 could draw a bit more suspicion. It's come within $0.02 a bit more often, has the same tight average, and has reported growth much more frequently than JDS. Foolish investors might want to look a little more closely to make sure everything's on the up and up there.

Note that I'm not concentrating on managing estimates here -- though management does that, too. However, if a management team always seems to deliver on estimates time and time again, you should probably dig a bit deeper, to see whether its interpretation of GAAP is getting a bit too fast and loose.

Investors crave consistency. That's one reason why its string of reliable results spurred GE's stock price to rise so much in the 1980s and 1990s. But the real world isn't consistent, and Foolish investors should account for that. If a company's results seem too steady to be true, Fools should proceed with caution.

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